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Steve Parsons: Copper Offtake Thesis Paying Off
Source: Brian Sylvester of The Gold Report (9/24/10)
Wellington West Senior Analyst Steve Parsons believes that competition among Asian smelters will drive these companies to seek guaranteed sources of metal concentrate. In fact, several companies with large copper deposits have either received generous offtake financings or been taken over. Steve thinks his evolving thesis will remain valid for the foreseeable future. In this exclusive interview with The Gold Report, Steve divulges the few companies he thinks remain targets.
Steve Parsons: What has happened is that Chinese copper consumption has remained strong. Earlier in the year, bullish sentiment toward copper was only reluctantly embraced as North American and European economic recoveries appeared tenuous. However, sentiment turned decidedly bullish midsummer as the protracted drawdown in London Metal Exchange (LME) inventories started to resonate with investors and metal traders—particularly when considered with strong Chinese consumption data from growth in the appliance market and social housing projects and improving Institute of Supply Management (ISM) data out of the U.S. More recently, the expectation of more quantitative easing (QE) policies in the U.S. and, thus a weaker dollar, is providing another leg up to copper prices.
TGR: Have we seen the end of copper's economic bellwether status?
SP: I don't think so, just that copper prices may have a stronger correlation with the status of China's economy and that of emerging markets than with the U.S.
TGR: How long do you expect copper to remain in the $3.57 range?
SP: I think there's a good chance it'll stay there for the next few years. In 2011, the market is likely headed toward a supply deficit in the neighborhood of some 400,000 tons. And that's in the absence of strong economies in the U.S. and Europe. If these economies pick up and there is restocking by end users, I think we could see even higher copper prices next year. The prospect of aging mines (i.e., declining grades, deeper and more-expensive mining) and declining production from some of the world's biggest mines could keep average prices at or above current levels through 2013—the point at which some big, new mines come online.
TGR: You mentioned concentrate. When you last talked with The Gold Report, you said "a growing trend spurred by continued tightness in the copper concentrate market has seen Asian smelter groups offer guarantees of low interest offtake financing in return for equity interest in copper concentrate-producing projects and offtake agreements to secure supply." First, please define an offtake agreement for our readers, and then further explain your investment thesis.
SP: An offtake is an agreement signed between a mining company and, typically, a smelter group, whereby the mining company will provide a set amount of concentrate for delivery to the smelter. The smelter charges a processing fee for that concentrate. Most of the big, undeveloped mines are likely to produce a copper concentrate.
What we like about tightness in the concentrate market, as an investment thesis, is that there's a reasonably clear path for investors to make money on copper development companies, irrespective of the weekly and monthly gyrations in the copper price.
Large copper development assets are scarce and largely undervalued, mostly due to project-financing concerns. When I interviewed with The Gold Report last time, we felt that these financing concerns were overblown because there was solid rationale as to why Asian smelters would provide offtake financing as a means to secure concentrate for their smelters in what remained a really tight concentrate market.
What's happening now is, not only are smelters trying to secure long-term supplies of high-quality concentrate with offtake financings; but, because smelting is such a low-margin business, the smelters are also intensifying their efforts to become more fully integrated from the mine to the smelter. That means they're taking equity interests in mining projects. That's going to continue, and development companies stand to benefit from this ongoing theme.
Not only are smelters intensifying efforts to take equity interests, but they're also competing with cashed-up mining companies that are also looking for growth through equity interests in development projects. You've got the smelters and the mining companies competing for a scarce number of high-quality projects.
TGR: Is that how Wellington West determines its coverage? You establish an investment thesis, and then find companies that are best suited to maximize that thesis?
SP: We did in this case. About three years ago, we recognized there was too much smelting capacity chasing too little concentrate and smelter operating margins would get squeezed to the point where it was not a sustainable business proposition. So, the smelter would have to go out and become more fully integrated. As a result, we selectively picked up coverage of companies with large development assets with no offtake deal in place, that are strategically large and not owned or junior ventured (JV'd) by a major.
TGR: Let's go back to what these smelters are looking for in mining projects. What's going to put some projects closer to the top of the list than others?
SP: For early stage development projects, the key consideration for the smelter, other than the strategic size of the asset, is to ensure there's no offtake deal in place for the concentrate. Smelters may also seek out assets where a JV interest can be earned, thereby moving toward a more fully integrated model. Other important considerations are capital-expenditure (capex) intensity, permitting environment and whether or not there's a good shipping lane to China.
Now that's the smelters. The other interested buyers of these development stories are mining companies. They look for the same attributes but, obviously, are less concerned with whether or not there's an offtake deal.
TGR: In these large deposits, there are often other metals—molybdenum, zinc or, in some cases, gold. What happens to the other metals?
SP: Typically, you get the other metals as byproduct credits; but you bring up an interesting point, because these copper porphyry deposits tend to be big and strategic. Not only are these assets coveted by smelters and base metals miners, but the porphyries that have copper and gold are also coveted by gold companies. Gold companies like them because these deposits can provide millions of ounces in gold reserves—the kind of reserves you can't find these days in gold-only assets. Goldcorp Inc.'s (NYSE:GG; TSX:G) deal with New Gold Inc. (TSX:NGD; NYSE.A:NGD) for a 70% stake in the El Morro copper-gold project in Chile is a fairly recent example.
TGR: So, copper-gold porphyry deposits are in demand because, not only are copper companies getting involved, but the large gold companies that often have the most cash flow are also looking at the high gold reserves. Are there some junior miners developing copper-gold porphyry deposits that are on the radar screens of the gold majors or even the diversified metals miners like Rio Tinto Ltd. (LSE:RIO; NYSE:TP; ASX:RIO) or BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF)?
SP: Yes, we believe there are still quite a few. One that's early stage but looks like it could be large is owned by Intrepid Mines Ltd. (TSX:IAU; AIX:IAU). It has an 80% interest in a project called Tujuh Bukit on the island of Java in Indonesia.
Tujuh Bukit is shaping up to be very compelling copper-gold porphyry. There's still some work that needs to be done to understand the quality of the copper concentrate. But it's very close to tidewater with a good shipping lane to China. Intrepid is coming out with the inaugural resource on Tujuh Bukit at the end of September.
TGR: That could be a catalyst for the share price.
SP: I would call it a first-pass resource update because there is a good chance it is going to get bigger.
TGR: What are some copper projects that you believe Chinese companies are eyeing to feed their smelters?
SP: Antares Minerals Inc. (TSX.V:ANM) is another likely target. It's only at the scoping study stage; however, this is one of the biggest undeveloped copper porphyries not owned or JV'd by a major and where the offtake is free and clear to do a deal. Antares has 13 billion pounds (Blbs.) of copper equivalent. It is big and in Peru—a country where the Chinese like to do business.
TGR: What's the next catalyst for Antares?
SP: Well, they're doing a 40,000-meter drill program. They will continue to drill and release results probably through the first quarter of 2011. The catalysts will likely be drilling related. The stock should also benefit from more mergers and acquisitions (M&A) in the space, as there are few remaining strategically large deposits available for purchase.
TGR: You have a $4.60 target price on Antares, and it's trading in that range. What copper price are you using in your model?
SP: It's based on $2 long-term copper, which is what we use for 2014 and beyond. Clearly, there is plenty of upside to our valuation at current prices. Moreover, what I like about the story is that these projects are rarely in the hands of junior companies. Antares is and will continue to benefit from this.
TGR: What about some others?
SP: Augusta Resource Corporation (TSX:AZC;NYSE.A:AZC;A5R:GR) is a good example of a stock we like, where the valuation is compelling but the theme has already partially played out. Augusta owns the Rosemont Copper project in Arizona. The company announced two deals in two weeks. The first was a strategic placement by Hudbay Minerals Inc. (TSX:HBM) for $30 million, and the second was a deal with Korea Resources Corporation and LG International Corp. that saw the consortium take a 20% project interest for $176 million and agree to an offtake deal with respect to 30% of the copper concentrate.
TGR: When will Rosemont enter production?
SP: It is contingent on permitting. If the company receives permits in the second half of next year, we're assuming an estimated start date in the second half of 2013.
TGR: What's your target price on Augusta?
SP: We just raised it to $4.90. There is good upside there. The reality is, if they do make good headway on the permitting and visibility on the permitting improves there, this stock could rerate to my target in an accelerated timeframe.
TGR: Do you have one more?
SP: The last one that I'll throw at you, which is a little bit contentious right now, is Taseko Mines Ltd.'s (TSX:TKO, NYSE.A:TGB) Prosperity copper-gold project in British Columbia. It is going through the permitting process. If it gets permitted, then it could also be a project the Chinese will be looking at to provide offtake financing for a strategic supply of concentrate.
TGR: So, the biggest hurdle there is the permitting. We've seen a few other projects in B.C. that didn't get beyond those hurdles. When do you expect permitting news?
SP: The expectation is that the federal government will make a decision by late September or early October.
TGR: If permitting is approved, could we see a real boost in Taseko's shares?
SP: It's an absolute game changer for Taseko. It would provide a +30-year mine life on Prosperity with very low cash costs.
TGR: If that project gets permitted, some other companies may take a run at Taseko.
SP: It would put Taseko on the radar screens of those companies looking for low-cost production growth.
TGR: Any other copper companies you're following that we have not talked about?
SP: There is Copper Mountain Mining Corp. (TSX:CUM). It has made the transition to a development company by securing an offtake deal. Now, Copper Mountain is one of the few projects we know of that is going into production next year. While it's not going to benefit from the offtake thesis, the valuation is still compelling and the company could very well be in the sights of one of the many cashed-up miners looking for production growth. This is the nearest-term production growth that is available.
TGR: Do you have a target price on Copper Mountain?
SP: Our target on Copper Mountain is $4. A potential game changer for the company is that it is drilling a geophysical anomaly below the pit. The company plans to drill four holes into it this year. Success would catapult Copper Mountain from a small- to mid-sized copper producer to, potentially, a larger copper producer that would fit into the wheelhouse of many more companies. Stay tuned. We should hear about that one in about a month or so.
TGR: Do you have some parting thoughts on the copper market?
SP: I would say this "offtake thesis" has been a low-risk, high-reward strategy for the past couple years. It's worked out extremely well, and we expect this thesis to persist for the foreseeable future.
Steve Parsons, P.Eng., a member of Wellington West Capital Markets' equity research team since April 2008, is a senior research analyst focused on the mining sector. Wellington West is an institutional equities firm that specializes primarily in the mining, energy and technology sectors. After earning his bachelors of engineering degree in mining at Queen's University, Steve worked as a metallurgical engineer for Placer Dome, and then moved on to a metallurgical consulting firm. Shifting to the investment side of the business after that, he signed up as a research associate with GMP Securities, concentrating on base metals initially and later joined MGI Securities as a research analyst.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp, Augusta and Copper Mountain.
3) Steve Parsons: I personally and/or my family own shares of the following companies mentioned in this interview: Copper Mountain. I personally and/or my family am paid by the following companies mentioned in this interview: None.